On 18 September 2017, what has become called “the safe harbour defence”, became available to company directors from claims against them for allowing the company to incur debts whilst insolvent (“insolvent trading”). This reform was part of the Government’s National Innovation and Science Agenda launched in late 2015.
Why was the safe harbour opened?
Australia’s insolvent trading provisions have been subject to strong criticism by various interest groups. It was claimed they discourage directors trying to implement restructuring proposals to turn businesses around and they bring about the destruction of value and job losses as a consequence of formal insolvency administrations. The government responded to these concerns and have provided directors with a safe harbour option allowing them to retain control of the company while receiving restructuring advice from professional advisers in a framework which still provides for the interests of creditors.
What the safe harbour is
The safe harbour is an additional defence for directors to a claim by a liquidator of the company, that they allowed the company to incur debts whilst insolvent.
The defence is available to a director if, after suspecting the company is or may become insolvent, the director starts to develop one or more courses of action or commences to take a course of action reasonably likely to lead to a better outcome for the company and its creditors. The person seeking to rely on the defence will bear the onus of the proof. The test a person must satisfy is a ‘reasonableness’ test.
What debts does the safe harbour protect the director from?
The defence is available in regard to debts incurred directly or indirectly with the course of action taken from the time of the commencement of the formulation of the course of action until the earliest of:
- The expiration of a reasonable time, if the course of action is not undertaken;
- The cessation of the course of action;
- When the course of action ceases to be reasonably likely to lead to a better outcome for the company;
- The appointment of an administrator or liquidator.
It is essential to recognise the safe harbour does not operate retrospectively. If the company has incurred debts whilst insolvent before the director has commenced developing or implementing the restructuring plan, the director may still be personally liable for these debts.
What will be considered in establishing that a better outcome is likely?
A better outcome means an outcome for the company that is better than the immediate appointment of an administrator or liquidator. In determining if a course of action is reasonably likely to lead to a better outcome for the company and its creditors', regard may be had to whether the director:
- Is properly informed of the company’s financial position; or
- Is taking appropriate steps to prevent misconduct by officers or employees capable of impacting the company’s ability to pay its debts; or
- Is ensuring appropriate financial records are maintained consistent with size and nature of company; or
- Is seeking advice from an appropriately ‘qualified entity’ who has been given sufficient information to give appropriate advice; or
- Is developing or implementing a plan for restructuring the company to improve its financial position.
What is a ‘qualified entity’ from an advisor perspective?
‘Appropriately qualified’ is used in the sense of “fit for purpose” and is independent of the formal qualifications. The director appointing the adviser is responsible for determining if the adviser is appropriate. The director should consider:
- Nature, size and complexity of the business;
- Adviser’s independence, professional qualifications, good standing and membership of appropriate professional bodies;
- Adviser’s experience
- Level of adviser’s professional indemnity insurance.
The qualifications of an adviser may vary on a case-by-case basis.
- Small business, simple structure - Lawyer, accountant or other technical advisers perhaps with experience in insolvency.
- Larger or more complex business - Properly qualified, special insolvency or turnaround practitioner who is a member of a professional insolvency or turnaround association, or a specialist lawyer.
- Large complex business - Team of turnaround specialists, insolvency practitioners, law and accounting firms.
When the safe harbour defence will not be available.
The defence will not be available if the company is failing to:
- Pay employee entitlements by the time they fall due;
- Give returns, notices, statements, applications or other documents as required by taxation laws.
These are important qualifications that directors should be aware of.
Further, a director cannot rely on company books and records to support the safe harbour defence unless the records have been provided to the administrator or liquidator of the company in accordance with legal requirements to do so.
The safe harbour will provide directors with a limited window of opportunity to obtain advice and formulate a proposal (a restructuring plan) that will be implemented, either informally continuing to use the protection of the safe harbour or formally via a scheme of arrangement or a voluntary administration under the Corporations Act 2001.
The bill will protect the director from being liable to compensate the company for a debt incurred when the company was insolvent if the debt was incurred in undertaking a course of action that is reasonably likely to lead to a better outcome for the company and the company’s creditors.
However the conditions a director must satisfy to demonstrate whether a course is reasonably likely to lead to a better outcome, will in our opinion, limit the availability of the safe harbour defence to only well run companies.
Informal restructuring of a financially distressed entity is extremely difficult. The safe harbour is not a magic spell that will suddenly hypnotise the company’s creditors and make them act in the company’s interests and not their own. Every creditor will have different interests and a statutory mechanism such as a scheme of arrangement or voluntary administration will be necessary to impose the will of a majority on the minority who could hold out in an informal restructuring.
For further information, please contact one of our Restructuring and Recovery specialists.